Three Myths About Equity Crowdfunding Debunked

Equity crowdfunding, where investors (accredited only for the moment) buy securities in privately owned companies, is still relatively new. The increasing appeal of investing in startups is understable for investors who are looking to diversify their portfolio, looking to get uncorrelated returns and have determined that their risk appetite is aggressive. However, there have been a number of claims about equity crowdfunding that I felt compelled to surface and address. Having been in the space since 2011, here are the top three misconceptions:

When the JOBS Act was enacted, as Mark Roderick a shareholder in Flaster/Greenberg law firm states, many people – especially angel investing groups – were concerned that a company raising money from the crowd would be precluded from raising additional money in later financing rounds. This, like so many of the other concerns raised about Crowdfunding, has proven to be a false alarm. In example,Pristine, a technology startup that leverages google glass to help bring seamless, hand free secure communication to the work force, raised their seed round of $750,000 with the help of Onevest in April of 2014. Less than five months later, Pristine went on to successfully raise their Series A round of $5.4 Million from institutional investors and venture capitlists.

There are ways to structure the crowdfunding offering to keep the cap table clean. One option is forming what’s called a “special purpose vehicle” or SPV, a vehicle used to pool investments from a larger group of individual investors into one entity. An SPV allows the founder to only add one new investor to the cap table, rather than having to add each individual new investor, thus keeping the cap table nice and clean. The only glitch with this approach is that if the SPV has more than 100 investors it becomes subject to the onerous requirements of the Investment Company Act of 1940, Roderick says. For a more complete summary of how this structure would work. Roderick adds, another way, aside from creating an entirely new vehicle for investing to steer clear from futures issues, is to build into the offering documents limited voting rights, limited anti-dilution rights, give no preemptive rights and add the right to admit additional investors with preferential rights to distributions, or simply offer another class of shares. Investors in crowdfunding typically do not expect to participate in the management of the enterprise. Instead, they expect to receive a financial instrument representing a share of future profits. With just a little thought and planning, there is no difficulty aligning the interests of the company regarding future financing with the expectations of the investors.

2. Only unsophisticated investors invest via crowdfunding platforms

Equity crowdfunding is very different. For example, we recently featured a startup investment deal on Onevest that raised as much as a quarter of a million dollars from a single individual who had institutional knowledge about the space and was a high level executive at a strategic firm. This directly contradicts the idea that crowdfunding investors will, for the most part, invest small amounts and not have a deep understanding of the vertical. Granted this is not the norm, it does happen.While good things may come in small packages, equity crowdfunding doesn’t always fall into that category. Equity crowdfunding often gets confused with rewards-based/donation-based crowdfunding on platforms like Kickstarter and Indiegogo where many people give a small amount of money in return for a reward or simply the good will or karma of helping a cool project succeed.

Current regulations permit only accredited investors to invest through equity crowdfunding portals. These sophisticated investors must satisfy at least one of the following criteria as outlined by the SEC: earn an individual income of more than $200,000 per year (or a joint income of $300,000 with a spouse) in each of the last two years and expect to reasonably maintain the same level of income, or have a net worth exceeding $1 million excluding residential assets. High-income earners are for the most part very busy and are unlikely to spend long hours searching for high growth startup investments, which is why what we do at Onevest provides value by vetting the startups and performing due diligence on the deals ahead of time.

3. Equity Crowdfunding is a last resort for founders so the startups must be junk

The glamour of brand name venture capitalists, established corporations or even celebrity investors like Ashton Kutcher or Mark Cuban (a popular phenomenon) has caused some people to view equity crowdfunding as a desperate move by founders to sell their “unpopular” equity. This simply isn’t the case. In fact, equity crowdfunding doesn’t replace other more traditional forms of fundraising from VC’s, angels, etc. but rather augments or complements these other avenues. High quality startups are leveraging equity crowdfunding to help close out their rounds. Take StyleLend, for example, a peer to peer fashion rental clothing company, a graduate of the prestigiousY Combinator accelerator that generates over 30% month over month average revenue growth. Another example is Imperative, an online professional development platform that personalizes the way people find and manage work and engage others while deepening the way companies engage and retain young talent. Imperative’s COO graduated from Stanford, and previously led operations for YouTube EDU at Google where he oversaw YouTube for Schools. Moreover, the CEO is author of ‘The Purpose Economy’ and a widely recognized social entrepreneur and authority on purpose in the workplace. Over the past few years the rumble around equity crowdfunding having lower quality startups has slowed down as investors see that credible platforms like AngelList, CircleUp or Onevest are here to stay and are changing the way the public gets access to startup investments.